Mergers And Acquisitions : Vodafone Controversy

INTRODUCTION

With the advent of India as second fastest growing economy in the world and owing to the niche of the Indian businessmen for risk and experiments with new business strategies, many new innovative methodologies have emerged for expansion of business and increase in efficiency. Today doing business has become a dynamic process. Economic, social, legal etc. are certain factors which affect businesses which involves growing demand of restructuring business operations.

RESTRUCTURING BUSINESS IS THREESOME CONCEPT

1. Expansion - A business can expand its operations through mergers acquisitions takeovers, joint venture and strategic alliances.
2.  Contract - A Business can contract its operations by sale, of its Assets, demergers, slump sales, and divestments.
3.  Change of ownership - This is done by share buy backs, preferential allotments, hostile bids, and public issues.[1]

Thus, depending upon circumstances and available resources, a company can opt to restructure its business for growth, expansion and to enhance its efficiency. With emergence of Globalization, there is a consensus among corporate leaders that mergers and acquisitions is the best business strategy for expansion. Both the inbound and outbound mergers and acquisitions have increased dramatically. According to Investment bankers, Merger & Acquisition (hereinafter referred to as “M&A”) deals in India will cross $100 billion this year, which is double last year’s level and quadruple of 2005.[2]

The Indian saga of mergers and acquisitions started taking the front seat, with the Tata Steel’s mega takeover of European steel major Corus for $12.2 billion. The biggest ever for an Indian company. This is the first big thing which marked the arrival of India Inc on the global stage of mergers and acquisition.

The latest milestone in these lines which is in the limelight is the much debated case of Vodafone acquisition of Hutchison Essar which involved the issue of tax liability. The question that arose in this case was whether the transfer of an Indian entity by one nonresident company to another will give rise to an incident of Capital Gain Taxation in India or not.

Service companies have also joined the M&A game.  For such companies, M&A are an effective strategy to expand their businesses and acquire global footprint. Sectors like pharmaceuticals, IT, ITES, telecommunications, steel, construction, etc, have proved their worth in the international scenario and the rising participation of Indian firms in signing M&A deals has further triggered the acquisition activities in India.

MERGERS & ACQUISITIONS

A merger is a combination of two companies where one corporation is completely absorbed by another corporation. The less important company loses its identity and becomes part of the more important corporation, which retains its identity. It may involve absorption or consolidation.

Merger is also defined as amalgamation. Merger is the fusion of two or more commercial organisations into one. All assets, liabilities and the stock of one company stand transferred to Transferee Company in consideration of payment in the form of:

• Transferee company’s equity shares
• Transferee company’s Debentures
• Cash
• A blend of above.[3]

Amalgamation is defined under section 2(1 B) of Income Tax Act, 1961 as follows:

[4]  "Amalgamation", in relation to companies, means the merger of one or more companies with another company or the merger of two or more companies to form one company (the company or companies which so merge being referred to as the amalgamating company or companies and the company with which they merge or which is formed as a result of the merger, as the amalgamated company) in such a manner that - 

(i) All the property of the amalgamating company or companies immediately before the amalgamation becomes the property of the amalgamated company by virtue of the amalgamation;

(ii) All the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company by virtue of the amalgamation;

(iii) Shareholders holding not less than nine-tenths in value of the shares in the amalgamating company or companies (other than shares already held therein immediately before the amalgamation by, or by a nominee for, the amalgamated company or its subsidiary) become shareholders of the amalgamated company by virtue of the amalgamation,  otherwise than as a result of the acquisition of the property of one company by another company pursuant to the purchase of such property by the other company or as a result of the distribution of such property to the other company after the winding up of the first mentioned company[5]

MOTIVES BEHIND MERGERS OF THE COMPANY

1. Economies of Scale: It involves the use of increase production to decrease per unit cost.
2. Increased revenue / Market Share: This motive is to absorb the major competitor and thereby attain monopoly and the freedom to set prices.
3. Cross selling: For example, a bank buying a stock broker could then sell its banking products to the stock brokers customers, while the broker can sign up the bank’ customers for brokerage account. 
4. Corporate Synergy: Better use of complimentary resources. It may take the form of revenue enhancement and cost savings. 
5. Taxes: A profitable can buy a loss maker to use the target’s tax right off i.e. wherein a sick company is bought by giants.
6. Geographical or other diversification: This is designed to smooth the earning results of a company, which over the long term smoothens the stock price of the company giving conservative investors more confidence in investing in the company. However, this does not always deliver value to shareholders.

Some studies have focused on identifying the specific reasons for the failure of mergers or acquisitions.  The following are the five major causes of merger failure:

• Poor strategic rationale.
• Mismatch of cultures.
• Difficulties in communicating and leading the organization.
• Poor integration planning and execution.
• Paying too much for the target company.[6]

TYPES OF MERGES

• Horizontal merger- A merger is said to be horizontal when two companies producing or rendering the same products or services or products and/or services which compete directly with each other. E.g.  Ford and Volvo
• Vertical merger- A customer and company or a supplier and company i.e. merger of firms that have actual or potential buyer-seller relationship. Ford- Bendix, Time Warner-TBS.
• Conglomerate merger – A Conglomerate merger is one where two or more companies with different line of work merge to diversify the products marketed. The companies may not be related to each other horizontally.

ACQUISITION

Taking possession of another business is also called as a takeover or buyout. It may be share purchase (the buyer buys the shares of the target company from the shareholders of the target company. The buyer will take on the company with all its assets and liabilities) or asset purchase (buyer buys the assets of the target company from the target company)

In simple terms, A merger involves the mutual decision of two companies to combine and become one entity; it can be seen as a decision made by two "equals", whereas an acquisition or takeover on the other hand, is characterized the purchase of a smaller company by a much larger one. In a merger of two corporations, the shareholders usually have their shares in the old company exchanged for an equal number of shares in the merged entity.[7]

DIFFERENCE BETWEEN MERGERS AND AQUISITIONS

Though the two terms mergers and acquisitions are often used interchangeably and are also used in such a way as if they are synonymous, however, there are certain differences between mergers and acquisitions. 

APPLICABLE LAWS

The following Applicable laws are divided into the following categories –

1. National M&A transaction:-

Companies Act,1956, Companies Court Rules,1959; Income Tax Act,1961; Central Sale Tax Act,1956; Indian Stamp Act,1899 and Competition Act,2000

2)  M&A transactions involving listed Companies:-

Securities and exchange Board of India (SEBI) regulations and Listing Agreements.

3)  International M&A transactions:-

Foreign Exchange Management Act, 1999[9]

PROCEDURE FOR AMALGMATION/MERGER

1)  Check Memorandum of Association (change accordingly).

2)  Scheme of Amalgamation / Merger should be drawn by the merging partners.

3)  The drawn scheme has to be considered in the Board meeting.

4)  An application should be given to the court to call Board meeting.

5)  A copy of the said application should also be given to Central Government.

6)  Send notices of General Meeting to shareholders along with the scheme.

7)  Notice Period shall not be less than 21 days.

8)  Notice can also be served by way of Advertisement.

9)  Scheme should be approved at General Meeting, by increasing authorized share capital and       by further issue of shares, as required.

10)  Forward promptly notice and proceedings of meeting to Stock Exchanges.

11)  Report the result of the meeting to Court.

12)  Move to Court for approval of the scheme by filing petition in 7 days in Form 40.

13) Advertise the date of hearing fixed by the court

14) On receipt of Order from the High Court, it is to be filed with the registrar of Companies.

15) Proceed to give effect to the scheme of amalgamation / merger as approved by High Court.[10]

WHAT IS THE NEED OF M&A IN INDIA?

The factors responsible for making the merger and acquisition deals favorable in India are:

1. Corporate investments in industry
2. Economic stability
3. “ready to experiment” attitude of Indian industrialists
4. Dynamic government policies

VODAFONE ACQUISITION OF HUTCHISON ESSAR

BACKGROUND AND FACTS

 Cayman Island Company called CGP investment held 52 % of share capital of Hutchison Essar Ltd., an Indian company. The share of CGP investment was held by another Cayman island company called Hutchison Telecommunication. The Assesses acquired share in CGP investment for the total consideration of US $ 11.08 billion from the second Cayman Island Company.

FACTS

• The Assessing Officer (AO) issued a show cause notice under Section 201 of the Income Tax Act, 1961 (Act) in view that as the ultimate asset acquired by the assesses were shares in an Indian company, the assesses ought to have deducted tax at source under Section 195 of the Act, while making payment to the vendor.
• This notice and further orders as to the payment of the tax amount and penalty were challenged on the ground that a non-resident had acquired shares of a foreign company from another nonresident, Section 195 had no application.
• The Bombay High Court has dismissed the assesse’s plea.
• The Supreme Court on 25^th October, 2010 adjourned the hearing in Vodafone’s appeal against the 8 September Bombay High Court order to 15 November, following the tax liability notice of the Income Tax department to the assesses of Rupees 11,218 crore in tax.

APPLICABILITY OF LAWS

Application of the Income Tax Act, 1961-Section 5(2) of the act enunciates that the income of nonresident from whatsoever source derived is included in the income if: (i) it is received in India; (ii) deemed to be received in India; (iii) deemed to accrue in India;(iv) arises in India; or

Under section 9(1) to accrue of the Income tax Act (Act), the following incomes shall be deemed arise in India or -

All income accruing or arising whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India.

We will consider, here, income accruing or arising whether directly or indirectly (1) through or from any source of income  in India or (2) through the transfer of a capital asset situated in India and apply it to transfer of shares by a non-resident to another non-resident, in a company incorporated abroad, the foreign company holding shares in the Indian company .

 The question to be examined is on the following facts: 1) shares transferred are held in the foreign company; 2) Transfer is by one non-resident to another non-resident; 3) foreign company held shares in the Indian company; 4) Indian company has property, asset, source of income and capital asset in India; 5) foreign company does not directly hold any property, asset, source of income and capital asset in India. 

 In the present case, the source of income of the shareholders in the foreign company is the operations of the subsidiary company in India. The gain of non-resident shareholders, on sale of shares in the holding company, accrues or arises in India. Thus, the capital gain has source in India.  Such income would be deemed to accrue or arise in India, since it accrues, directly or indirectly through from any source of income in India.

JUDGMENT OF THE BOMBAY HIGH COURT

• An assessee who engages in legitimate business activities is entitled to plan his transactions in a manner that would reduce the incidence of tax and the department is not entitled to disregard it on the ground of motive.
• Under Section 5 & 9 of the Act, the nexus for charging a non-resident is provided by the receipt or accrual of income in India.
• The position of the capital asset is the crucial jurisdictional condition that must be fulfilled in order to attract chargeability to tax of income arising from the transfer of a capital asset.
• If the tax amount payable is not assessable in India, there is no question of tax being deducted by the assessee.[11]
• The essence of the transaction was to achieve the transfer of control over the Indian company although the transaction involved two non-residents and shares of a foreign company and the transfer of the solitary share of the Cayman Islands Company was put into place as a mode of effectuating the goal. The court has considered the substance over form of the transaction.
• As the consideration was paid for acquisition of control premium, use and rights to the Hutch brand in India, non-compete agreement with the Hutch group etc, it will have to be apportioned by the AO to determine which portion has a nexus within the Indian taxing jurisdiction and which lies outside.
• Accordingly, as the transaction between the assessee and Hutchison Telecommunications had sufficient nexus with Indian fiscal jurisdiction, the AO did have jurisdiction to initiate proceedings against the assessee for failure to deduct tax at source.

CONCLUSION OF THE JUDGEMENT

• Even though the assessee maintains in its response that the said transaction has taken place between two non-residents and it involves the transaction of the shares of a foreign company, as a result of such transaction the assesses has become the controlling authority of an Indian company i.e. the income from such Indian company will be the income of the assessee. Since there is this nexus between the foreign transaction and the resulting income from an Indian company to the assessee, therefore the assessee is bound to have deducted a requisite tax amount to be paid to the Indian government as a result of its transaction.
• Under Section 195 of the Act: The obligation to deduct tax arises where the sum payable to a nonresident is chargeable to tax under the provisions of the Act. For the obligation to deduct to arise, the entire sum payable need not be income chargeable under the Act. If the sum payable to a nonresident represents income or if income is hidden or otherwise embedded in it, tax is required to be deducted on the sum.
• The judgment passed by the Bombay High Court, if upheld by the Apex Court, will have an impact on the Foreign Investments in India. The foreign companies will be cautious to enter the Indian capital market through acquisitions since it will lead to costlier deals for buyers, urging the foreign companies to assess their tax liabilities prior to entering into such deals.

SUCCESSFUL TOP 5 MERGERS IN INDIA

1. Tata Steel’s mega takeover of European steel major Corus for $12.2 billion. The biggest ever for an Indian company. This is the first big thing which marked the arrival of India Inc on the global stage.
2. Vodafone’s purchase of 52% stake in Hutch Essar for about $10 billion. Essar group still holds 32% in the Joint venture.
3. Ranbaxy’s sale to Japan’s Daiichi for $4.5 billion. .
4. HDFC Bank acquisition of Centurion Bank of Punjab for $2.4 billion.
5. Reliance Industries taking over Reliance Petroleum Limited (RPL) for 8500 crores or $1.6 billion.

CONCLUSION

At this nascent stage where mergers and acquisitions in Indian market have reached growth rate of 167% it is important to understand the implications of these mergers. But at the same time such ventures may go down the road of failure. Where it creates job opportunities by way of increased vacancies there could be a layoff of jobs due to the failure of the venture. One of the most peculiar features of merger in India is that there is tax benefit under it act but on the contrary the debate of taxability is arising in almost all cross border Mergers & Acquisitions. Therefore it is recommended that a separate statue governing the same should be established, so that a second Vodafone-Essar dispute never rings the sirens of the Indian Income tax department.